The February 12th Couch Potato mentioned "... Now the question is, are prices beginning to pull back or will there be sustained overbought conditions... In our daily SPY chart you can see that the price along with the momentum indicators and oscillators are starting to lose momentum and are actually trying to turn down. Over the next few days we should know whether this is a headline inspired 'head fake' with prices immediately recovering or is the market starting to pull back from the current overbought level..."
At this point, the major indexes price drop to recent near term support levels is turning out to be a 'head fake' as stocks refuse to go down. Looking at the SPY weekly chart down below will confirm that since the beginning of the year, stocks have 'bulled' higher with nary a pause. Prices have consolidated a bit over the past few weeks, but from a technical perspective this should be considered bullish. Price consolidation usually helps alleviate overbought or oversold conditions, and prices are usually expected to move in the direction of the current trend after the consolidation ends. Recently we mentioned that price pullbacks will likely be minor because buyers who have been on the sidelines might be tempted to jump back in the game and buy the dips.
Stock price corrections usually happen when most people least expect. Currently there are signals that some pundits will suggest were a warning sign if prices do pull back. In the most recent American Association of Individual Investors (AAII) survey the numbers are showing the highest bullish levels since the April 2011 cyclical peak. 51.6% of the investors polled are bullish while only 20.2% bearish and 28.2% are neutral. Further, financial advisors are equally bullish. The latest Investors Intelligence Advisors Sentiment survey is 54.8% bullish and only 25.8% bearish. Again, this is the most optimistic reading since spring 2011. Also, short interest on the NYSE and NASDAQ has fallen over 5% in the last two weeks alone. As stocks move higher there are fewer short sellers that need to buy to cover short positions. Some people believe that with fewer short sellers placing bets, more shorts miss the opportunity if stock prices drop and the market will decline more readily with fewer short contracts. What might be a more ominous bearish sign is in the month of February, corporate officers unloaded $2.3 billion of company stock while insider buying totaled only $150 million (a 15 to 1 seller to buyer ratio). Again, insider selling rations are similar to the numbers just prior to last summers correction.
It looks likely that stock prices should push higher in the near term, but there is a strong case for some a significant pullback within the next few weeks. If stocks do reverse course and head down the major indexes 50-day moving averages should be firm support with buyers stepping in to prop up the market.
SPY Position Update
SPY closed at $136.41 on Friday â€“ the February position closed approx. $1,400 in the red
SPY is priced ABOVE its current 14-day EMA (see SPY chart down below)
SPY is trading ABOVE its 20-day Bollinger Band SMA (see SPY chart)
SPY is priced ABOVE its 50-day simple moving average (see SPY chart)
SPY is ABOVE its 200-day simple moving average (see SPY chart)
Relative Strength Indicator (RSI) is extremely bullish (See SPY chart)
Moving Average Convergence/Divergence (MACD) is turning neutral (See SPY chart)
The January 17th Couch Potato published a February expiration SPY bear call spread
On February14th we suggested either closing out the $134 strike price short call and exiting the position, or rolling up the short call to the $136 strike price
The February 16th publication proposed closing out all short contracts prior to option expiration the next day (see tables below)
The February 13th Couch Potato published a March expiration SPY Iron Condor/Bear Call Spread Combo (i.e. 20 call spread contracts and 10 put contracts) (see tables below)
SPY Risk Analysis
We closed out our February short contracts prior to option expiration this past Friday and will now focus on managing the March positions we established last week.
DIA Position Update
DIA closed at $129.23 on Friday - the February position closed approx. $700 in the black
DIA is priced ABOVE its current 14-day EMA (see DIA chart down below)
DIA is trading ABOVE its 20-day Bollinger Band SMA (see DIA chart)
DIA is priced ABOVE its 50-day simple moving average (see DIA chart)
DIA is ABOVE its 200-day simple moving average (see DIA chart)
Relative Strength Indicator (RSI) is extremely bullish (See DIA chart)
Moving Average Convergence/Divergence (MACD) is neutral (See DIA chart)
The January 23rd Couch Potato published a February expiration DIA bear call spread
The February 16th publication proposed closing out the $129 short call contracts prior to option expiration the next day (see tables below)
DIA Risk Analysis
We closed out our February short contracts prior to option expiration this past Friday and have not yet opened a March DIA position.
As with initiating the trade, the decision process for exiting our Iron Condor/Bear Call spread combo position will be simple:
Anytime the market maker is willing to accept a limit price of less than .11 on one of our short strikes, buy back all the short contracts and sell the long positions on the same spread. However, if it is a few days prior to the expiration date, we may be able to hold out for a .05 bid.
If one of our short strikes is penetrated (closing price above our short call or below the short put) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
Exiting this position prior to expiration we will probably â€œleg outâ€ of each trade by first unwinding either the bear call spread or the bull put spread; and close out the other side of the spread as a separate order. The timing of closing out each side of the Iron Condor is dependent on following our Exit Rules described above.
Discipline is one major attribute that delineates successful traders from those who are unsuccessful, especially as it relates to managing losing trades. And this characteristic is even more vital for traders who rely on trading credit spread strategies. Most people who trade credit spreads recognize that it is a strategy designed to generate consistent income and usually does not provide exorbitant gains. The Achilles heel of credit spreads is that the large losses that can occur might wipe out months of gains if the trade is not managed properly. One can do all the expert technical and fundamental analysis they want and the market trend could be ideal as you enter a trade. But regardless of the level of upfront analysis to make sure the executed trade was set up properly, if the market wants to go against the trade it will in a heartbeat. The point is not to diminish the value of performing thorough analysis to set up a prospective trade, this is an absolutely vital part of the process to manage trade risk and give the trade the best chance to be profitable. But regardless of what some people might advertise, it is inevitable that at some point traders will have to deal with a losing trade.
Whether they realize it or not, everybody who participates in the stock market has trading plan. Some investors may not have a definitive written trading plan, and the strategy may change daily. But whatever is one's process to get in and out of the market that is their plan. Part of the trading plan should be to identify at what point you believe the odds are against the trade working out. And if it does end up being a losing position what is the strategy for minimizing potential losses. After opening a trade, if the market goes against the position, depending on the time component and whether prices move relatively orderly, the objective is to get of out a losing month with minimal damage. Trading discipline is the key. If the trading plan has been vetted and is a proven working document, then the only element that would hurt investors is managing emotions. Even investors who have been trading many years have to deal the anxiety associated with trading. The point is that when trading credit spreads, if/when the market turns against the spread, if you can harness your emotions and honor the trading plan usually one can minimize the loss. This is really the name of the game to help achieve long term success with spread trading, keep the losses small and infrequent.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.